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‘Fedamageddon’: Federal Reserve Considers Unprecedented Steps to Boost National Economy

October 21, 2010

FedamageddonAs Americans head to their nearest polling station to cast their midterm election ballots on Nov. 2, the Federal Reserve will be winding down its next policy committee meeting.

On November 3, the Fed is expected to announce its latest plans to try and boost the country’s faltering economy — plans that may include unprecedented “quantitative easing,” or attempts to spur economic growth and keep prices steady by buying up more government debt.

On Oct. 15, chairman Ben Bernanke hinted of the move, saying there appears to be a “case for further action” on the part of the Federal Reserve. Bloomberg reports:

Estimates of the size of a bond-purchase program have varied. Bill Gross, Pacific Investment Management Co.’s co- founder and manager of the world’s biggest mutual fund, said Oct. 8 on Bloomberg Television that the central bank may buy about $100 billion in government debt a month, or $1.2 trillion over the next year. A Citigroup Inc. survey of clients released yesterday showed an average expectation of about $560 billion.

Richard Clarida, global strategic adviser at Newport Beach, California-based Pimco, said in an interview with Deirdre Bolton on Bloomberg Television’s “Inside Track” that he expects the Fed to focus its buying on the 5- to 10-year maturity range.

Richmond Fed President Jeffrey Lacker said yesterday a new round of quantitative easing “would be a hard case to make,” while his Philadelphia counterpart, Charles Plosser, said he’s “less concerned about deflation risks” than some officials.

But not everyone thinks this plan is the right one.  “In terms of Treasuries, I wouldn’t touch them with a 10- foot pole, except maybe on the short side,” investor Steven Leuthold told “In the Loop” on Bloomberg Television. “Yields are so skimpy it makes no sense for people to be putting money in anything other than very, very short-term bonds.”

FedamageddonTIME’s Curious Capitalist blog asked Thursday, “Will the Federal Reserve Cause a Civil War?”

Usually, there is generally a consensus about what the Federal Reserve should do. When the economy is weak, the Fed cuts short-term interest rates to spur borrowing and economic activity. When the economy is strong and inflation is rising, it does the opposite. But nearly two years after the Fed cut short-term interest rates to basically zero, more and more economists are questioning whether the US central bank is making the right moves. The economy is still very weak and unemployment seems stubbornly stuck near 10%.

The problem is the Fed only directly sets short-term interest rates. And they are already about as close to zero as you can go. That’s why Ben Bernanke has been recently talking about something called “quantitative easing.” That’s when the Fed basically creates money to buy the long-term bonds that it doesn’t directly control, and drive down those interest rates as well. That should further reduce the cost of borrowing for large companies and homeowners. Some people are calling this “QE2” because the Fed made a similar move during the height of the financial crisis when it bought mortgage bonds.

The financial blog Zerohedge specifically warns of the threat of civil unrest if Bernanke and the Federal Reserve move forward with “QE2”:

In a very real sense, Bernanke is throwing Granny and Grandpa down the stairs – on purpose. He is literally threatening those at the lower end of the economic strata, along with all who are retired, with starvation and death, and in a just nation where the rule of law controlled instead of being abused by the kleptocrats he would be facing charges of Seditious Conspiracy, as his policies will inevitably lead to the destruction of our republic.

While concerns of a second civil war may seem far-fetched, TIME’s Curious Capitalist warns that lower rates do tend to “favor borrowers over savers” and this policy could create serious problems:

[T]he largest borrowers in the country are banks, speculators and large corporations. The largest spenders in our country though tend to be individuals. Consumer spending makes up 70% of the economy. And the vast majority of consumers are on the low-end of the income scale. So I think it is a valid question to ask whether the Fed’s desire to drive down interest rates at all costs policy is working. Companies are already borrowing at low rates. They are just not spending. …

The problem with “quantitative easing” then is that eventually, the artificial economic supports it supplies will eventually have to be removed.

John Taylor, a Fed scholar at Stanford University, says that this process is what could be “quite disruptive.”  Avoiding a double-dip recession now may cause you to just delay an inevitable double-dip later.

“It will be hugely disappointing if the Fed didn’t do anything,” Brian Edmonds, head of interest rates at Cantor Fitzgerald LP tells Bloomberg.  “The Fed can’t afford to disappoint the market.”

While election results are announced, many eyes will be fixed on the Fed’s upcoming announcement.

“In the center of the ring is the Nov. 3 announcement,” says David Ader, head of government bond strategy at Stamford, Connecticut-based CRT Capital Group LLC.  “Something’s going to be done, but they don’t know the size or the methodology. As the Fed enters the blackout period, so does the bond market.”

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